4 basic calculations reveal the state of your finances
An older survey revealed that almost 40% of Americans described math as their least favorite subject, while a much smaller 23% of Americans described math as their favorite academic discipline.
But some math is simple even for math haters—and some really simple equations can be really important if you want a clear picture of how you're doing financially.
If you want to better understand your financial life, it's time to get out your calculator and dive right in to calculating four important numbers that reveal almost everything you need to know about your financial health.
- Savings / income
If you want to be a financial success, you need to save at least 20% of your income. At least 15% of that amount should be saved for retirement, while the rest can go toward accomplishing other financial priorities such as saving for a house down payment, funding college for your kids, fully funding an emergency fund, or even saving for a vacation.
To find out if you're meeting this goal, divide the amount you're saving by your income. You could do this on a monthly or annual basis. If you save $500 per month and bring home $4,000, your savings rate is 12.5% ($500/$4,000). If you save $12,000 per year and bring home $50,000, your savings rate is a much healthier 20% ($10,000/$50,000).
If your savings rate is too low, there are a few simple steps you can take right now to get closer to that ideal 20% ratio, like tracking your spending and creating a budget. You can also allocate your raises toward savings and slowly increase the amount you're putting aside until you reach this important 20% threshold.
- Debt / income
Americans collectively owed $12.96 trillion in the third quarter of 2017, according to the Central Reserve Bank of New York. You probably owe at least some money, whether in the form of a student loan, mortgage, car loan, credit cards, or all of the above.
Having some debt isn't necessarily bad if you've borrowed to get an education or invested in a home that's appreciating in value. But if your debt is too high, it can prevent you from accomplishing financial goals—either by leaving you with too little money or by disqualifying you from obtaining financing.
To see how you're doing with debt, divide your monthly payments by your monthly income. You can do this calculation twice if you're a homeowner: once factoring in your mortgage and once without housing debt included.
If payments come to around $1,000 monthly and you make $4,000 per month, you're using 25% of your income to pay debt. If this includes your mortgage debt, you're in great shape. If it doesn't, you may be in trouble. If you save 20%, spend 30% on housing, and pay another 25% toward debt, you have just 25% of your income—$1,000 per month or $250 per week—to cover all your costs such as gas, groceries, and insurance. This may not be enough, and your savings goals may suffer.
Your debt-to-income ratio is important not only because too much debt in relation to income makes saving difficult; mortgage lenders also won't give you a loan if your debt, including housing costs, exceeds 43% of income. You don't want to be closed out of buying a house because you owe too much, so make an aggressive plan to repay your debts if your ratio is too high.
- Housing costs / income
If your housing costs exceed 30% of your income, you're probably living beyond your means and may have too little cash left over to accomplish other goals.
To find out how your housing costs compare with income, divide your monthly expenditures for your mortgage (or rent), property taxes, insurance, and homeowner's association fees. If your total housing costs are $1,200 and you have a $4,000 income, your housing costs take up 30% of your income—right about where you need to be.
The bad news is, 38.9% of Americans spent more than this 30% threshold on housing costs in 2015. If you have a low income or live in a high-cost area, you may feel you have no choice but to devote more than 30% of monthly pay to housing. However, mortgage lenders typically won't give you a loan if your housing costs exceed 29% percent of what you make in a month.
Options to reduce this ratio could include moving to a lower cost-of-living area, downsizing to a smaller house, renting out rooms, appealing your property taxes, or increasing your income.
- Net worth (Assets - debts)
Totaling up your assets and subtracting the amount of debt you owe will give you your net worth. An estimated 16.6 million Americans have a negative net worth, many because of student loans. While it's natural for your net worth to be negative when you're first starting out, your net worth should steadily rise as you pay down debt, earn income, and acquire more property.
Tracking your net worth is a great way to get a big picture view of how you're doing financially. Ideally, you'll want a net worth of at least $1 million around retirement so you'll never have to worry about money during your golden years.
The good news is, increasing your net worth will happen naturally if you make responsible money decisions like spending less than you earn, prioritizing debt repayments, and acquiring assets—such as stocks and bonds—that tend to go up in value over time.
How's your financial score?
Now that you've done the math, are you happy with your numbers? If not, you have plenty of opportunities to spend less, save more, get serious about repaying debt, and optimize your financial situation. Take action today and do the math again and again over time to see how your finances are improving.